Tuesday, May 31, 2011

WHAT A PUBLIC BANK COULD MEAN FOR CALIFORNIA

California is the eighth largest economy in the world, and it has a debt burden to match. It has outstanding general obligation bonds and revenue bonds of $158 billion, largely incurred for infrastructure. Of this tab, $70 billion is just for interest. Over $7 billion of California’s annual budget goes to pay interest on the state’s debt.

As large as California’s liabilities are, they are exceeded by its assets, which are sufficient to capitalize a bank rivaling any in the world. That’s the idea behind Assembly Bill 750, introduced by Assemblyman Ben Hueso of San Diego, which would establish a blue ribbon task force to consider the viability of creating the California Investment Trust, a state bank receiving deposits of state funds. Instead of relying on Wall Street banks for credit – or allowing a Wall Street bank to enjoy the benefits of lending its capital – California may decide to create its own, publicly-owned bank.

On May 2, AB 750 moved out of the Banking and Finance Committee with only one nay vote and is now on its way to the Appropriations Committee. Three unions submitted their support for the bill – the California Nurses Association, the California Firefighters, and the California Labor Council. The state bank idea also got a nod from former Secretary of Labor Robert Reich in his speech at the California Democratic Convention in Sacramento the previous day.

Why a State Bank?

California joins eleven other states that have introduced bills to form state-owned banks or to study their feasibility. Eight of these bills were introduced just since January, including in Oregon, Washington State, Massachusetts, Arizona, Maryland, New Mexico, Maine and California. Illinois, Virginia, Hawaii and Louisiana introduced similar bills in 2010. For links, dates and text, see here.

All of these bills were inspired by the Bank of North Dakota (BND), currently the nation’s only state-owned bank. While other states are teetering on bankruptcy, the state of North Dakota continues to report surpluses. On April 20, the BND reported profits for 2010 of $62 million, setting a record for the seventh straight year. The BND’s profits belong to the citizens and are produced without taxation.

The BND partners with local banks in providing much-needed credit for local businesses and homeowners. It also helps with state and local government funding. When North Dakota went over-budget a few years ago, according to the bank’s president Eric Hardmeyer, the BND acted as a rainy day fund for the state. And when a North Dakota town suffered a massive flood, the BND provided emergency credit lines to the city. Having a cheap and readily available credit line with the state’s own bank reduces the need for massive rainy-day funds (which are largely invested in out-of-state banks at very modest interest).

The Center for State Innovation, based in Madison, Wisconsin, was commissioned to do detailed analyses for the Washington and Oregon bills. Their conclusion was that a state-owned bank on the model of the Bank of North Dakota would have a substantial positive impact in those states, increasing employment, new lending, and government revenue.

What California Could Do with Its Own Bank

Banks create “bank credit” from capital and deposits, as explained here. Under existing capital requirements, $8 in capital can be leveraged into $100 in loans, drawing on the liquidity provided by the deposits to clear the outgoing checks. Assuming a 10% reserve requirement (the amount in deposits normally held in reserve), $8 in capital and $100 in deposits are sufficient to create $90 in loans ($100 less $10 held back for reserves).

In North Dakota (population 647,000), the Bank of North Dakota has $2.7 billion in deposits, or $4000 per capita. The majority of these deposits are drawn from the state’s own revenues. The bank has nearly the same sum ($2.6 billion) in outstanding loans.

California has 37 million people. If the California Investment Trust (CIT) performed like the BND, it might amass $148 billion in deposits. With $12 billion in capital, this $148 billion could generate $133 billion in credit for the state (subtracting 10%, or 14.8 billion, to satisfy reserve requirements).

There are various ways the state could come up with the capital, but one possibility that would not require new taxes or debt would be to simply draw on the treasurer’s existing pooled money investment account, which currently contains $65 billion in accumulated revenues dispersed to a variety of funds. This money is already invested; a portion could just be shifted to the CIT. Since it would be an investment in equity rather than an expenditure, it would not cost the state money. Rather, it would make money for the state. In recent years, the Bank of North Dakota has had a return on equity of 25-26%. Compare the 25-30% lost in the two years following the 2008 banking crisis by CalPERS, the California Public Employees’ Retirement System, which invested its money on Wall Street.

There are many inviting possibilities for applying the CIT’s $133 billion in credit power, but here is one easy alternative that illustrates the cost-effectiveness of the approach. Assume the bank invested $133 billion in municipal bonds at 5% interest. This would give the state close to $7 billion annually in interest income – nearly enough to pay the interest tab on the state’s debt.

Choosing Prosperity

What California can do with its own bank, other states can do as well, on a scale proportionate to their populations and economies. North Dakota has a population that is less than 1/10th the size of Los Angeles; the BND produced $62 million in revenue last year and $2.2 billion in loans. Larger states could generate much more.

We have been trapped in an austere neo-liberal economic model in which the only alternatives are to slash services, raise taxes, and sell off public assets, all in a futile attempt to “balance the budget” in a shrinking economy. We need to start thinking outside the box. We can choose prosperity, and public banks are a key tool for achieving that end.